There has been considerable media interest in the apparent differences in the approach of the Finance Minister and the Reserve Bank of India (RBI) over the issue of new bank licences. While the former is reportedly keen on the RBI speeding up its process of issuing new licences, the latter would first like to beef up existing regulation in order to be a more effective regulator when the sector is further opened up. The RBI specifically wants to equip itself with powers to supersede the boards of banks in case the situation so warrants.
The so called differences between the Finance Ministry and the RBI are over the timeframe for issuing new bank licences. The larger issue of whether new private banks should be licensed at all has long since been settled. In his 2010 budget speech, the then Finance Minister, Pranab Mukherjee, mentioned the possibility of issuing licences for opening a few new banks to the private sector, to be promoted by non-banking finance companies (NBFCs) and industrial houses. Banks promoted by NBFCs are not new, and the government’s decision to allow a few more NBFCs to start banks is in line with existing policy. However, enabling industrial houses to start banks is controversial for a variety of reasons.
(1) The reform era that began in the 1990s saw the entry of new private banks. Following the Narasimham Committee recommendations, new private banks, very adequately capitalised and having the latest technology platforms, were allowed in. Ten new banks made their appearance in the mid-1990s while two more — Kotak Mahindra and the Yes Bank — were given licence in 2002.
The question, therefore, is not about private banks per se but over the entry of those promoted by industrial houses.
(2) There are both historical and contemporary reasons pointing to the need for a cautionary approach. Almost all the leading public sector banks of today — Bank of Baroda, Bank of India and Punjab National Bank — were in the private sector. All of them were either promoted by large industrial houses or had significant connections with them. The two-stage bank nationalisation that began in 1969 was preceded by a period of social control. The official justification for both was to check what was then seen to be their common practice of banks being at the beck and call of their promoters, indulging in cross-lending and not having any prudential restraints in their dealings with industrial houses. A second reason given was to reorient the banks towards national objectives.
Critics of nationalisation have said that the decision was a cynical one, based more on politics than economics. However, after the two-stage nationalisation — the second one was in 1972 — for good or bad, Indian banking came to be identified with the public sector. More recently, in the 1990s, Indian banking, especially the segment confined to metropolitan areas, had a taste of world-class banking, with the advent of the new-generation private banks. Many of the features of modern day banking that have enhanced the quality of personal banking and added to the convenience can be traced to this development. However, even though these banks have opened branches in non-metro areas, their focus has been on the metros. This point is of relevance given the policy push being given to financial inclusion. In fact, a main justification for the new bank licensing policy is that they will spread banking far and wide, to areas and customers so far not covered by the financial sector. Whether recent experiences of banks, especially the new private banks, vindicate that approach are a moot point.
Although not spelt out, RBI’s caution is basically confined to the entry of industrial houses into banking.
The structure of Indian banking so far, industrial houses do not directly own a bank — although in many cases they have sizable shareholding in individual banks — has a lot in its favour.
Through a variety of regulatory rules, the RBI has ensured that no individual group, irrespective of its shareholding, can control a bank.
The situation will change radically if large business houses get a direct foothold. For them, banking will not be the core or even the main business. No matter what safeguards are put in place, it will be a herculean task for the government and the RBI to keep a watch over the infringement of rules. Inter-connected shareholding will stress regulators, and is not a desirable outcome of reform. That is why the RBI wants more powers to check possible shenanigans.
The RBI’s draft rules for licensing new banks are understandably stiff. The capital requirements are pegged at Rs.500 crore. Eligible private sector promoters will be entities and groups with diversified ownership, sound credentials and integrity and having a track record of at least 10 years. Those having even an exposure of 10 per cent to speculative sectors of real estate and broking over the past three years are barred.
The RBI wants a corporate sector in which all the financial activities of the promoter group will be ring-fenced from their other activities. This, it hopes, will provide a measure of comfort to the depositors of the new banks.
So, in the next few weeks, there might be action on the bank licensing front. Of particular interest will be the entry of business groups.
The RBI’s task is not easy. No matter how stiff the qualifying standards are, it is impossible to keep a really determined entity from gaming the system. Also, the subjectivity that is impossible to avoid in any guidelines will be the loop hole.